The Beauty of Deflation

by Claudio Grass, Gold Silver Worlds The Eurozone has been hovering around a 1% inflation rate, getting closer to zero during 2014, nothing close of the ambitious 2% benchmark set by central banks. Any small downward adjustment in the inflation rate will put it in the negative territory, allowing for prices to spiral downward. The West is genuinely fearful of deflation. Headlines in leading papers were very strong in reflecting this fear, describing deflation as “the world’s biggest economic problem”, or the “nightmare” that stalks Europe that will lead to its “descent” and collapse. The real question is why do our governments fear deflation? Why do they perceive it as the chronic disease that could infect our economy and why do they go to such great lengths to avoid this “taboo”? The mainstream argument says we should avoid deflation because it causes a drop in overall demand and lower growth (Germany and other European states have been living a slowing recession recently which called for a downgrade in 2014 growth expectations). Also, deflation implies a decline in prices, lower corporate earnings and asset values, particularly real estate. But the greatest concern to governments is not deflation itself; the real concern is the impact of deflation on the already over-indebted economies of Europe. Seven of the Eurozone countries are projected to have public debt to GDP ratios of over 100% next year! The worry is quite legitimate as Europe is on the verge of a debt-deflation spiral. With deflation, the burden on the already highly indebted governments increases making a default even likelier. So what are policymakers doing to “tackle” this problem? As always, policymakers opt for the easy way out. Interestingly enough, they expect a turnaround of “fuelled” growth in 2015, driven by ECB President Mario Draghi’s quantitative easing (QE). QE means there will be more money printing that will increase the overall debt even further. Instead of questioning the methodology itself, analysts expect an impact from this policy. The ECB’s current priority is obviously to stimulate growth the American way: facilitate bond purchases with newly created money. On its website, the ECB states: “In a deflationary environment monetary policy may thus not be able to sufficiently stimulate aggregate demand by using its interest rate instrument. This makes it more difficult for monetary policy to fight deflation than to fight inflation.” Unfortunately, all this means is that the ECB is convinced that monetary policy is not enough, and believes in further interventionist measures to avoid deflation at all costs. The direction that the ECB has taken throughout this year strongly reflects this – the negative interest rate is one of them. But really how negative will the interest rate go? Mr. Draghi has asserted his commitment to consider all available options to redress threats of deflation, including structural adjustments – but these are too time consuming. The easy way out is more debt and more printing of money. The delusion that is inflation Before he was Chairman of the United States Federal Reserve, Ben Bernanke claimed in 2002 that “…sufficient injections of money will ultimately always reverse a deflation”. Unfortunately for Bernanke, the Japanese cannot argue in favor of this opinion. Deflation was not unfamiliar to Bernanke. Japan went through a decade of deflation since the early 1990s and it has been “trapped” there since, not because of deflation itself but rather because it chose to redress deflation mainly by reflating the economy. It even implemented its QE program back in 2001 but with mixed results. It is living proof that monetary easing only perpetuates the “crisis” and does not repair the damage. So why go through that road again? The Austrians say deflation plays a major part in the inevitable bust Bernanke himself said that deflation is feared because it increases the real value of debts. Truth is deflation accentuates money, or rather the value of money. We believe that it strips all the excess nominal value added in the price of a product, making it reflect its true value and worth. Therefore we ask why the fear from deflation? In our view and as highlighted by the Austrian School economists: the bust is inevitable. The bust allows for the market to correct itself. Intervention in the economy, particularly through monetary expansion will only prolong the time span until the bubble bursts, and it will be more severe the longer it is delayed. Yes, we see there is a beauty to deflation. Continue Reading>>>

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